Archive for October, 2011

The video below covers both fundamentals (Europe) and technicals. As of Friday’s close, there were some bearish set-ups similar to those seen in late July 2011. At the end of the video, the following concerns are discussed relative to the latest “final” bailout for Europe:

Bank recapitalization plan

Stability fund

Use of leverage

Implementation details lacking

Difficult to get commitments

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode. If you want to skip the technicals, comments on Europe begin at the 18:05 mark.

Thursday’s bailout announcement in Europe represented significant progress in that debt reduction is what has to take place. However, the odds of Europe being off the market’s radar going forward are almost zero. The question is how long will it take to become a problem again - three days, three months, six months? We believe the stock market rallied more based on the relief European leaders demonstrated they can make difficult decisions, rather than based on the feeling everything is fine in Europe. Reuters hit on some key points:

Euro zone leaders are as far as ever from finding a lasting solution to the bloc’s underlying problem of economic divergence, despite their latest progress in managing the symptoms of its debt crisis.

“This is another step in the right direction, but it is not enough to get us to the end game,” said Stephane Deo, chief European economist at UBS. “It buys time but it does not address the fundamental problem of the sovereign debt crisis.”

Nearly 35 percent of Greek bonds are in the hands of public institutions such as the European Central Bank (ECB) and is not subject to the mooted writedown. As a result, Greece’s debt would still be an eye-watering 120 percent of gross domestic product in 2020 — exactly the level of late 2009. And even that assumes decent economic growth and ambitious structural reforms including large-scale privatization of state assets.

“From the macroeconomic point of view, if it’s purely a 50 percent ‘haircut’ on the nominal bonds, without an extension of the maturity and a reduction of the coupon, I’d still be reasonably suspicious about the sustainability of Greek debt,” Deo said.

The European Central Bank (ECB) is similar to our Fed. They have reluctantly been purchasing Italian and Spanish bonds hoping to buy leaders time to stabilize the markets. When the ECB is buying bonds something is wrong. The “euro-saving” deal was announced on Thursday and stocks zoomed higher. The bond market is what matters here since access to credit is the key issue. How did bond buyers react? Not well.

In a new bond offering on Friday, where bids are taken to determine the rate of interest the market demands, Italy’s borrowing costs hit new euro-era highs. Think about that - (1) the worst on record bond auction took place AFTER the bailout deal was announced , and (2) the ECB is still buying Italian bonds, which means the interest rate set by the “market” is artificially reduced via the central bank’s purchasing power. What would Italy’s interest burden have been in a real market auction (no ECB)? Until Italy can finance its government at reasonable rates and with no central bank involvement, we still have a major problem. Early Saturday morning, Reuters reported:

European Central Bank President Jean-Claude Trichet said in an interview in a German newspaper to be published on Sunday that the euro zone sovereign debt crisis was not yet over and that it was too early for the all-clear signal. He said the ECB will carefully track the progress of governments’ reform measures and said the time had now come to “see some action.” “The crisis isn’t over,” Trichet told the German newspaper, according to an advance text released early on Saturday. He said the precondition for that was “that the rules of the Stability and Growth Pact are more thoroughly and more aggressively implemented.” “The quick and complete implementation of the decisions is now absolutely decisive,” Trichet said.

The market’s attention will now shift toward Italy, a country “too big to fail and too big to bail”. More from Reuters via the Calgary Herald:

Italy’s borrowing costs jumped to record levels on Friday, underlining its vulnerability at the heart of the eurozone debt crisis and skepticism about whether the struggling government of Prime Minister Silvio Berlusconi can deliver vital reforms. The 6.06 per cent yield paid at an auction of 10-year bonds was the highest since the launch of the euro and not far from the level reached just before the European Central Bank intervened in August to cap Rome’s borrowing costs by buying Italian paper. Italy, the eurozone’s third largest economy, is once more at the centre of the debt crisis, with fears growing that its borrowing costs could rise to levels that overwhelm the capacity of the bloc to provide support amid chronic political instability in Rome. Berlusconi in a speech in Rome said the record yield would weigh on the country’s finances, but insisted Italy would meet its target of balancing the budget by 2013.

Initial relief over Europe’s latest attempt to end its debt crisis faded on Friday as investors fretted about the plan’s lack of detail and grew more skeptical about Italy’s turnaround effort. The wan response from bond markets underscores how challenging it will be for European leaders to convince financial markets that Thursday’s broad agreement is sweeping enough to enable troubled countries such as Italy and Spain to work their way out from mountains of debt.

“Italy remains a big problem,” said Alessio de Longis, a portfolio manager at OppenheimerFunds. Italy has been failing to deliver on promises, he said. Instead “it’s only talk—chiacchiere in Italian,” he said.

The firepower of this fund…is not enough to calm fears,” said Silvio Peruzzo, an economist at RBS Global Banking & Markets in London.

Rallies often end after the last buyer buys and the last short is covered. Short-term peaks often occur after a day or two of relatively small moves (up or down) on low volume. Unless volume picks up significantly, we are headed for a low volume session. Compared to the same period on Thursday NYSE volume is tracking 29% lower and the NASDAQ is 34% behind yesterday’s pace. SPY has not even traded 50% of a typical day’s volume yet. The QQQs (NASDAQ) have traded 32% of a normal session’s volume. Obviously, this is a relatively minor issue in the grand scheme of things, but low volume is often indicative of declining interest from buyers at current prices. Buyers want to buy after a pullback.

Just when you thought it was safe to go back in the water - From CNBC:

“We fear that the so-called ‘Super Committee’ of both Republicans and Democrats that has been charged with putting for a credible and material deficit reduction program will do nothing of the sort and will end up falling apart because of bilateral bickering,” Dennis Gartman, hedge fund manager and author of The Gartman Letter, wrote Friday. “The committee has a Nov. 23 deadline, and from the discussions and rumours thus far there is no chance that anything credible shall be put forth by that date.”

The eurozone Plan to Save the World has made US stock charts look like somebody lit a fuse under them, but on charts of eurozone sovereign bond yields, the Plan has left no evidence of its existence.

We mentioned yesterday stocks rallied strongly as TARP came together in the United States. This morning’s bond auction in Italy did not go well with investors demanding the highest yield since the euro’s creation. The higher the yield, the higher the perceived risk of default. This entire bailout package is aimed at getting bond yields to stabilize in Europe, allowing countries like Italy access to relatively cheap credit. The bond market was not impressed with the bailout package, at least at this morning’s bond auction in Italy. This from Comstock Partners, who admittedly tend to err on the bearish side of the fence:

Our initial reading of the reports coming out of Europe does not exactly inspire a great deal of confidence. On the surface it seems to be just another statement of intentions with all of the details to be worked out later—and, of course as the saying goes, “the devil is in the details”.

The EU itself in its release calls the plan a “broad agreement” to increase bank reserves. We would emphasize the word “broad.” Banks would be recapitalized subject to the approval of a number of policies still to be determined. It intends to broaden the rescue fund to a trillion Euros, ask Greek bondholders to take a haircut of at least 50% and force the banks to recapitalize by June 30th. How all of this is going to happen remains unclear. And the haircuts apply only to Greek debt. The hope is that the markets would gain enough confidence to ring-fence Spain and Italy from following in Greece’s footsteps. The markets have bought the story so far, but how long that feeling lasts is highly uncertain, particularly in view of the violent nature of recent trading.

As for the U.S. economy, although we’ve seen a small recent bump following the summer debt-ceiling circus, the economy remains in the doldrums. Consumer confidence remains near all-time lows as a result of the weak labor market. Consumer spending has improved somewhat lately, but only because households lowered their savings rates. Personal income is still scraping along the bottom. Core capital goods expenditures were up, but surveys indicate the business investment may slow in coming months. Confidence in the small business sector is still at historical lows. Recent unwanted inventory accumulation may also point to a coming slowdown in production. Housing is scraping along the bottom and may drop even more as the foreclosure backlog comes on to the market.

The economic sectors that have shown some recent improvement are generally coincident or lagging indicators while leading indicators appear to be showing some weakness. The ECRI Weekly Leading Indicator is at levels indicating a recession ahead. This indicator has a good record of predicting past recessions and has never forecast one that didn’t occur. If this prediction is accurate, we will be going into a recession in such a fragile economic environment that we would expect any recession to be severe. Some of the statistics are; 9.1% unemployment, 22% of homeowners underwater, about 5 million homes in inventory or shadow inventory, home prices continuing to decline, and debt (all sectors) at historically high levels.

The CCM Bull Market Sustainability Index (BMSI) and CCM 80-20 Correction Index have popped into the very low end of bullish territory. Unless the market pulls back soon, they will both clearly be giving bullish signals.

“If we’re not seeing the sovereign debt markets turn around, that is a red flag,” Michael Darda, the Stamford, Connecticut-based chief economist and chief market strategist at MKM Partners LP, told Bloomberg Television. “Equity markets have gotten optimistic here. One of the things that bothers me is the euro-zone debt markets have not registered the same degree of optimism, and that’s really the core of the problem.”

While the market was very strong today, we are at the top end of a range that could push prices back (see last chart). At 3:50 p.m., the S&P 500 ETF (SPY) had not yet traded even an average number of shares. SPY normally trades 318M shares per day – today’s level was 301M, which is relatively low considering the magnitude of the gains – not bearish, but not impressive either.

We should get a better read on things tomorrow after the euphoria from the European bailout begins to diminish. There is no question damage has been done to the bearish case. It is not unusual for the S&P 500 to close above its 200-day moving average in a bear market (sits at 1,274 currently). Therefore, today’s close of 1,284 is within bear market norms. It is also not unusual to rally back to one of the trendlines from the bull market’s peak, which is exactly what we have done. What is concerning for the bear case is how stocks have come up – fast and with very small and short-lived pullbacks, which is bullish.

The more key levels the market takes out, the more bullish the move becomes. The current rally is pushing the outer envelope of bear market norms. The dot-com bear market rallied back to a trendline that corresponds with roughly 1,325 on the S&P 500 (compare A-1 and A-2 in the two charts below). We closed today at 1,284 - so technically a sharp reversal is far from out of the question, but the odds are dropping as we march higher.

This rally has blown through numerous forms of resistance, but trend channels connecting highs and lows tend to carry a little more weight. The market may plow through LINE A below (top of chart), but it is worth seeing if gains above today’s high of 1,292 can be sustained. Notice how the trendlines acted as both support (green arrows) and resistance (red arrows). The orange arrow shows possible resistance for current prices.

Last weekend, we did some calculations relative to how far stocks rallied in the last bear market from the March 2008 low to the May high. Using numerous points of reference, the high end of similar targets for the current rally fell between 1,290 and 1,300 (based on % moves above similar areas), meaning the rally in 2008 carried back to a level corresponding to 1,300 before failing. Again, 1,290 to 1,300+ is pushing the outer limits of bear market bounds, but historical precedent tells us bear rallies can surprise on the upside. The bulls are making progress, but the bearish case has not been extinguished yet.

The Troubled Asset Relief Program (TARP) was a program of the United States government to purchase assets and equity from financial institutions to strengthen its financial sector during the financial panic of 2008. On Nov. 12, Treasury Secretary Hank Paulson said the bailout money would be used for a broader campaign to bolster the financial markets and make loans.

A similar announcement was made last night in Europe. TARP did spark a 26% rally off the November 2008 low, but 100% of the gains were wiped out as the market made lower lows (much lower) over the next 70 days. We have to respect further upside in the short-term, but we also have to respect the possibility of lower lows over the next six months.